IAI Actuarial Core Principles · Business Economics · Balance of payments and exchange rates
Covered interest rate parity holds. Spot is Rs 75 per dollar. One-year interest rates are 8% in India and 4% in the US. Which one-year forward rate (Rs per dollar) is consistent with parity, to the nearest paisa?
The forward rate is Rs 77.88 per dollar. Covered parity requires forward over spot to equal one plus the Indian rate divided by one plus the US rate, 1.08/1.04, so 75 multiplied by 1.03846 gives about 77.88.
- ARs 72.12
- BRs 75.00
- CRs 77.88Correct
- DRs 78.00
- Rs 81.00
Explanation
Forward = spot x (1 + rupee rate)/(1 + dollar rate) = 75 x 1.08/1.04 = 75 x 1.038462 = Rs 77.88. Rs 78.00 uses the simple 4% difference and is not exact. Rs 72.12 inverts the ratio (wrong direction).
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